Good times fail to roll for our main lenders

Good times fail to roll for our main lenders

Dan White looks at where the big Irish banks, with flat underlying profits and tiny loan growth, go from here

Chief executive Bernard Byrne of AIB Photo: Bloomberg

Both of the main Irish banks reported their first-half results late last month. On July 27, AIB announced pre-tax profits of €760m for the first six months of this year, unchanged from the first six months of 2017, while Bank of Ireland rolled up on July 30 with an “underlying profit before tax” of €500m.

Apparently even more good news was the fact that, more than a decade on from the crash, the two main domestic banks are growing their loan books once again – with both AIB and Bank of Ireland announcing €500m increases in their “net loan books”.

The two main banks have also returned to paying dividends to their shareholders. So what’s not to like about their interim results?

So far so good, but look more closely at the numbers and it quickly becomes apparent that things aren’t quite so rosy for the two banks as their interim results announcements would have us believe.

Let’s start with the interim profit numbers. Even by its own admission the AIB pre-tax figure was unchanged on that of the previous year. This standstill was only achieved through a €130m write-back of previous loan loss provisions, up from €19m in the first half of 2017.

It was a similar story at Bank of Ireland with a loan loss write-back of €81m. This compared to a loan loss write-off of €59m in the first half of 2017, a €140m turnaround.

The Bank of Ireland results are further complicated by the inclusion of its New Ireland life and pensions subsidiary. Bank of Ireland paid out €641m in claims in the first half of 2018, down by €239m on the €880m paid out in the first half of last year.

While one can argue ad nauseam about what should or should not be included or excluded when seeking to get an accurate fix on underlying bank profitability, it seems clear that the post-crash recovery in bank profits has run its course.

Another sign that, despite the apparent increase in net lending, things are still not hunky dory for the banks is that their net interest income, the difference between what they receive in interest from their borrowers and what they pay out in interest to their depositors, was down.

AIB’s net interest income fell by 1.5pc to €1.06bn while Bank of Ireland’s net interest income was down by 6.5pc to €1.07bn.

How does this reduction in net interest income tally with the apparent increase in net lending? A partial explanation is probably the, very gradual, re-emergence of competition in the Irish banking market. Good news if you are a bank customer but bad news if you are a bank shareholder.

The other main reason is almost certainly the fact that there is less to the apparent increase in net lending than meets the eye.

Let’s start with AIB. It claims that its ‘net loan book’, ie loans less provisions, increased by €500m in the first six months of 2018.

However, this figure was only arrived at after allowing for the sale of bad loans. Factor this out and the net loan figure actually fell by about €100m to €59.9bn.

Even accepting the €500m figure at face value, AIB’s net loans to customers grew by less than 1pc during the first half of 2018.

Loan growth was similarly anaemic at Bank of Ireland, €500m or 0.65pc in the year to the end of June 2018.

Both banks made great play of the reduction in their non-performing loans. AIB knocked another €2.7bn off its non-performing loans in the first half and the total now stands at €7.5bn, still almost 12pc of its total loan book while Bank of Ireland cut its non-performing loans to €5.9bn, about 7.5pc of its total loan book.

In addition to loans it categorises as non-performing, AIB lists a further €5.2bn as ‘criticised’. When these loans, about which AIB obviously has concerns, are added to non-performing loans it can be seen that there are still question marks over the quality of more than 20pc of AIB’s loan book.

How many of these criticised loans would unravel in the event of a significant spike in interest rates or a Brexit-induced downturn in the Irish economy?

Unfortunately, Bank of Ireland doesn’t provide the same level of detail on currently performing loans about which it has concerns, but the same question still applies.

Instead of growing their loans books, AIB and Bank of Ireland are piling up capital instead. At the end of June AIB had a common equity tier 1 (CET1) capital ratio of 17.6pc while Bank of Ireland’s CET1 was 14.1pc.

These capital ratios will increase even further thanks to the Central Bank’s decision that the banks hold a counter-cyclical capital buffer equivalent to 1pc of their Irish loan books from July 2019. This will force AIB to keep about another €600m of capital on its balance sheet and Bank of Ireland about €500m.

At the same time as the banks were reporting less-than-stellar interim results the ESRI was forecasting Irish economic (GNP) growth of 5.3pc this year and 3.9pc next year. This is easily the fastest growth being experienced by any European country.

This extremely strong economic growth is making itself felt throughout the economy.

The number of people at work in the first quarter, 2.22 million, is now well above its pre-crash high of 2.13 million. Rents are now more 25pc above their pre-crash high while house prices have recovered by 76pc from their 2013 lows.

The hole in the public finances has disappeared with the Department of Finance projecting a deficit of just 0.2pc of GDP this year.

The growth is everywhere it would appear, except bank profits and lending. Weighed down by a rump of bad legacy loans and much heavier capital requirements, they appear unable to translate the current good economic times into improved financial performance.

All of which begs the question: If the banks can’t grow profits and lending when the economy is growing like the clappers, the property market has largely recovered from the crash and employment is running at record levels, when can they?

It may not come as much consolation to the Irish banks, but their predicament is not a unique one.

British bank Barclays reported a 30pc fall in pre-tax profits last week. Meanwhile the Eurostoxx Index of European bank shares has fallen by 14pc since the beginning of the year. This compares to an 11pc fall in the AIB share price and a 4.5pc increase in the Bank of Ireland share price over the same period.

For banks everywhere the future will be one of much tougher regulation, lower profits and less lending.